As with any other merger analysis, we need to examine the present value of the incremental
cashflows. The cash flow today from the acquisition is the acquisition costs plus the dividends
paidtoday, or:Acquisition of Hybrid–$550,000,000Dividends from Hybrid$150,000,000Total–
$400,000,000Using the information provided, we can determine the cash flows to Birdie Golf
from acquiringHybrid Golf. All earnings not retained are paid as dividends, so the cash flows for
the next five yearswill be:
Year 1Year 2Year 3Year 4Year 5
Dividends from Hybrid$38,400,000$12,800,000$29,400,000$41,400,000$59,000,000Terminal
value of
equity600,000,000Total$38,400,000$12,800,000$29,400,000$41,400,000$659,000,000To
discount the cash flows from the merger, we must discount each cash flow at the
appropriatediscount rate. The terminal value of the company is subject to normal business risk
and should bediscounted at the cost of capital, while the dividends are equity cash flows, and as
such, should bediscounted at the cost of equity. The present value of each year’s cash flows,
along with theappropriate discount rate for each cash flow is:
Discount rateYear 1Year 2Year 3Year 4Year 5
Dividends16.9%$32,848,589$9,366,578$18,403,643$22,168,806$27,025,856PV of
value12.4%334,441,139Total$32,848,589$9,366,578$18,403,643$22,168,806$361,466,995An
d the NPV of the acquisition is: NPV = –$400,000,000 + 32,848,589 + 9,366,578 + 18,403,643 +
22,168,806 + 361,466,995 NPV = $44,254,610.07
CF EBIT Depreciation Tax Capital requirements
Revenue Cost Tax Capital requirements
Another quirk in the tax laws involves surplus funds. Consider a fi rm that
has free cash fl ow—cash fl ow available after all taxes have been paid and after all positive
net present value projects have been fi nanced. In such a situation, aside from purchasing
fi xed-income securities, the fi rm has several ways to spend the free cash fl ow, including:
1. Paying dividends.
2. Buying back its own shares.
3. Acquiring shares in another fi rm.
We discussed the fi rst two options in an earlier chapter. We saw that an extra dividend
will increase the income tax paid by some investors. A share repurchase will reduce the
taxes paid by shareholders as compared to paying dividends, but this is not a legal option
if the sole purpose is to avoid taxes that would have otherwise been paid by shareholders.
To avoid these problems, the fi rm can buy another fi rm. By doing this, the fi rm avoids
the tax problem associated with paying a dividend. Also, the dividends received from the
purchased fi rm are not taxed in a merger.
CHAPTER 25 C-83
C-84 CASE SOLUTIONS
1. V*b = Vb + /\ V
= 68.75 x 8m = 550 + incremental CF
NPV = V*b – Cost to firm A of the acquisition
[Link] the acquisition is a positive NPV project, the most Birdie would offer is to increase the
currentcash offer by the current NPV, or:Highest offer = $550,000,000 + 44,254,610.07Highest
offer = $594,254,610.07The highest share price is the total high offer price, divided by the
shares outstanding, or:Highest share price = $594,254,610.07 / 8,000,000 sharesHighest share
price = $74.28
3.
To determine the current exchange ratio which would make a cash offer and a
68.75/ 94 = 0.73 shares of Birdie shud b given against each share of Hybrid
0.73 x 8m = 5.84 m
4. 74.28/94 =0.79 shares of Birdie shud b given against each share of Hybrid
0.79 x 8m = 6.32 m
total